Cairn shares tank on fears of a royalty kick in the butt

Shares of Cairn India, the Rajasthan oil producer which Vedanta Resources has sought to buy from its UK promoters, have gone weak in the knees, dropping nearly 10% from last Thursday.

The stock, which had been bravely holding up at around Rs 330 since April while the Nifty index fell 10%, is now adrift. It fell to a low of Rs 298 on Tuesday, before correcting a bit to Rs 305.65.

[caption id=“attachment_29039” align=“alignleft” width=“380” caption=“Getting a stock beating. Parth Sanyal/Reuters”]  [/caption]

Analysts cite two reasons for the fall. The first is the recent drop in crude oil, which will adversely impact the company’s performance. Oil prices, which are currently trading at $94 a barrel (Nymex), have fallen by nearly 8% in June. For every dollar’s fall in oil price, the company tends to lose more than Rs 50 lakh a day.

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The other angle that can have a more lasting impact on the company is its deal with Vedanta. Analysts believe that a recent group of ministers (GoM) meeting has agreed to ONGC’s demand that Cairn, or its successor, should pay the royalty bill currently being footed entirely by ONGC on oil sales.

ONGC owns 30% in Cairn’s Rajasthan oilfields, but pays the entire royalty at the rate of 20% of the crude oil price. This has made ONGC’s investments in the company loss-making.

ONGC had pointed to this anomaly a month before the deal between Cairn and Vedanta was announced last year. It had asked the government to treat royalty like a tax that could be deducted (recovered) from the sale proceeds of oil before profits were split between the partners. This point was opposed by Cairn as well as Vedanta.

However, analysts say that the GoM is now asking Cairn and Vedanta to bear 70% of the royalty burden, which, according to some, can be a deal breaker. Cairn currently produces 1,25,000 barrels of oil a day, or 45,000,000 per annum. This would result in Cairn shelling out over Rs 2,000 crore as its share of royalty. In 2010-11, the company posted a profit of Rs 6,270 crore. Observers expect the company to report a profit of Rs 8,400 crore in 2011-12 if it does not pay any royalty. This amount will fall by over Rs 2,000 crore if it has to shell out the royalty.

What is also worrying the market is Cairn’s proposal for increasing its production from 1,25,000 barrels to 3,00,000 barrels a day. The company has asked the government to allow it to ramp up production, but this has been delayed as the issue of royalty has been linked to increased output. The outgo of royalty that Cairn might have to pay will be made up by an increase in production.

Any delay in decision-making will cost both the nation and the company’s shareholders.